Noteworthy Retail Leasing Decisions:
Kohler v. Bed Bath & Beyond of Cal., LLC, 780 F.3d 1260 (9th Cir. 2015), the Ninth Circuit Court of Appeals held that the nation's leading housewares retailer was not liable for alleged violations of the ADA in the common area parking lot in front of its store. Even though Bed Bath & Beyond paid into a common maintenance fund, the court held that the ADA does not impose "upon tenants liability for ADA violations that occur in those areas exclusively under the control of the landlord." This decision suggests that landlords can no longer expect to pass liability for ADA violations in common areas to their tenants. See http://www.calbar.org/rpsection/e-newsletter/rp-e-newsletter_2015-10_web.html#rec2
Grand Prospect Partners, L.P. v. Ross Dress for Less, Inc.
Prior to the Fifth Appellate District Court’s decision in Grand Prospect Partners, L.P. v. Ross Dress for Less, Inc. (2015) 232 CA4th 1332, a well-recognized remedy for the failure of a cotenancy requirement was for the tenant to abate or reduce the amount of rent it was required to pay. However, the Grand Prospect case now forces landlords and tenants to assess the actual economic harm that will be caused to the tenant by such a failure, or else risk having their lease provision invalidated as an unenforceable penalty.
Grand Prospect Partners, LP ("Grand Prospect") owned and operated part of a shopping center in Porterville, California. Another parcel in the same center was owned by Mervyn’s Department Store ("Mervyn’s"), on which Mervyn’s operated a retail store. On April 4, 2008, Grand Prospect entered into a commercial retail lease with Ross Dress for Less, Inc. ("Ross") which contained a cotenancy provision—insisted on by Ross—that gave Ross the right not to open its store and to withhold rent if Mervyn’s did not occupy at least 76,000 square feet of leasable floor area in the center, or if Mervyn’s ceased operations and was not replaced by an acceptable retailer within 12 months. Ross also had the option of terminating its lease in the event the cotenancy failure continued for a period of 12 months.
Mervyn’s filed for bankruptcy and closed its store prior to Ross’s lease commencement date. Grand Prospect and Ross attempted to negotiate a lease amendment pursuant to which Ross would open its store and pay reduced rent until Grant Prospect found a replacement anchor tenant. But the parties were unable to reach such an agreement, and Ross elected to not to open its store or pay rent, as permitted by the existing cotenancy provision. Grand Prospect then sued Ross, challenging the enforceability of the cotenancy clause.
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Tax Reform Initiatives Propose to Repeal IRC Section 1031
There are three legislative proposals currently under consideration that recommend eliminating or severely restricting the application of IRC Section 1031.
The Obama Administration FY 2016 Proposed Budget limits the deferral of gain for real estate exchanges to $1,000,000 per taxpayer, per year. Additionally, the FY 2016 Budget completely repeals exchanges for artwork and collectibles.
House Ways & Means Committee Chairman Paul Ryan announced that he intends to introduce a comprehensive tax reform bill prior to the August Congressional recess. The proposal he inherited from the former Ways & Means Committee Chair Dave Camp included complete repeal of Section 1031.
Senate Finance Committee Chairman Orrin Hatch stated that June/July is the time to do a tax reform bill and his five Committee Working Groups are charged with providing their input to him by the end of April. The proposal he inherited from the former Senate Finance Committee Chair Max Baucus suggests either a repeal of Section 1031 or a limitation on the like-kind standard to a "similar or related in service or use" standard.
California Businesses Required to Electronically File Tax Returns
Effective January 1, 2015, California Assembly Bill 2754 (AB 2754) requires business entities to electronically file (e-file) their tax returns for taxable years beginning on or after January 1, 2014. Under the new law, the following types of returns must be e-filed:
Corporations: Forms 100, 100S, 100W
Partnerships: Form 565
LLCs: Form 568
Exempt organizations: Form 199
If a business entity required to e-file fails to do so, they will be subject to a $100 fine for the initial e-file failure and $500 for each subsequent failure.
According to the State of California Franchise Tax Board, the reason for AB 2754 is to reduce income tax return processing costs and error rates. Exception waivers may be requested if the taxpayer is unable to meet the requirements due to technology constraints, an undue financial burden, or other circumstances that constitute reasonable cause and not willful neglect.
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The trial court found both the rent abatement and termination rights to be unconscionable and unreasonable penalties. The jury awarded the landlord $4,701,990.83 in total damages, $672,100 of which constituted unpaid rent and $916,275 or which constituted attorneys’ fees. On appeal by Ross, the Court of Appeal reversed in part and affirmed in part, modifying the trial court’s judgment to award damages only for unpaid rent.
The appellate court held that the rent abatement remedy of the cotenancy provision constituted an unenforceable penalty rather than an enforceable (if "imaginatively drafted”) contractual condition. First, because Mervyn’s owned its space in the shopping center, Grand Prospect could neither affect Mervyn’s decision to close its store nor lease Mervyn's space to another tenant. Grand Prospect therefore had no alternative course of performance. Moreover, after a lengthy discussion on procedural and substantive unconscionability (both of which the court found lacking in this case because the parties were sophisticated and experienced in retail lease negotiations, and their negotiations involved several drafts of the letter of intent and lease), the court turned to the issue of whether the rent abatement was reasonable.
Under California law, a penalty is unreasonable (and therefore unenforceable) if “the value of the money or property forfeited or transferred to the party protected by the provision bears no reasonable relationship to the range of harm anticipated to be caused to that party by the failure of the provision’s requirements.” In applying this rule, the court compared (1) the value of the property forfeited by Grand Prospect and (2) the anticipated harm or damages that Ross was likely to have suffered by the failure of the cotenancy requirement.
The court found that there was no reasonable relationship between the total value of Grand Prospect’s rent forfeiture and Ross’s anticipated harm. The value of the total property forfeited by Grand Prospect totaled approximately $39,500 per month—potentially for the entire 10-year term, while the evidence
presented at trial established that Ross did not anticipate any losses or adverse impact on its business as a result of Mervyn’s closure. In fact, the trial court determined that Ross had never even attempted to determine the impact on its sales due to Mervyn’s closure, and had availed itself of its remedies under the cotenancy provision as a negotiation tactic to pressure Grand Prospect to lower its rent through the remainder of the term. Since the amount forfeited by Grand Prospect was in no way related to Ross’s anticipated harm, the rent abatement portion of the cotenancy provision was deemed to be unenforceable.
However, the appellate court found that Ross’s termination right was not an unenforceable penalty, reasoning that under California law, no forfeiture results from terminating a commercial lease because of the occurrence of contingencies that sophisticated parties have agreed on and that have no relation to any act or default of the parties.
The “take home” message for both landlords and tenants is that California courts may be more likely to enforce an option to terminate rather than allow a tenant to withhold rent. Although an alternative rent provision based on a tenant’s gross sales is likely to pass muster under Grand Prospect Partners, if a tenant wishes to avail itself of a rental abatement as a remedy for a cotenancy failure, it should reasonably estimate the costs and losses it would incur if a cotenant were to shut down or downsize, and the parties should only allow for the withholding of rent to the extent of such costs and losses. In addition, for both practical and now legal reasons, landlords may justifiably force tenants’ hands by requiring them either to resume paying full rent or terminate the lease after a stated period of time (e.g., 12 months) to avoid Grand Prospect’s uncertainty about the enforceability of rent abatement provisions.
The federal Defend Trade Secrets Act, recently signed into law by President Obama, allows a company to pursue the misappropriation of a trade secret that occurs on or after the May 11, 2016, as long as proper notice of immunity is given to employees and independent contractors.
Under the DTSA, employers must notify any new employee, consultant or independent contractor that they cannot be held liable, either criminally or civilly, if they disclose a trade secret that is made in one of the following situations:
a) in confidence to a federal, state or local government official, either directly or indirectly, or to an attorney, solely for the purpose of reporting or investigating a suspected violation of law;
b) in a complaint or other document filed in a lawsuit or other proceeding, if such filing is made under seal.
This can be as simple as adding language in a standard non-disclosure agreement and does not have to be a separate document. Going forward, it is strongly advised that employers include the proper notice.
While the DTSA specifically cites new contracts entered into after the date it went into effect, it is unknown how courts would act in a situation if there was a trade secret misuse after the DTSA enactment date but when the individual’s agreement or contract had been entered into before that date. For this reason, employers should consider updating existing contracts with employees, independent contractors and consultants alerting them to their immunity in certain situations in order to protect themselves.
Ramifications for employers that fail to give the required notice can include the following:
(i) An employer cannot recover exemplary damages available under the DTSA; and
(ii) An employer cannot recover any of its own attorneys’ fees or costs (in the event a trade secret is willfully and maliciously misappropriated).
Below is one example of wording that could be used to fulfill the required notice:
"Notwithstanding the foregoing nondisclosure obligations, pursuant to 18 USC Section 1833(b), [Employee/Contractor] shall not be held criminally or civilly liable under any federal or state trade secret law for the disclosure of a trade secret that is made: (1) in confidence to a federal, state, or local government official, either directly or indirectly, or to an attorney, and solely for the purpose of reporting or investigating a suspected violation of law; or (2) in a complaint or other document filed in a lawsuit or other proceeding, if such filing is made under seal."